Mathematical Modeling in Finance with Stochastic Processes

(Ben Green) #1

162 CHAPTER 5. BROWNIAN MOTION


Section Starter Question


Some mathematical objects are defined by a formula or an expression. Some
other mathematical objects are defined by their properties, not explicitly by
an expression. That is, the objects are defined by how theyact, not by what
theyare. Can you name a mathematical object defined by its properties?


Key Concepts



  1. We define Brownian motion in terms of the normal distribution of the
    increments, the independence of the increments, and the value at 0.

  2. The joint density function for the value of Brownian motion at several
    times is a multivariate normal distribution.


Vocabulary



  1. Brownian Motionis the physical phenomenon named after the En-
    glish botanist Robert Brown who discovered it in 1827. Brownian mo-
    tion is the zig-zagging motion exhibited by a small particle, such as a
    grain of pollen, immersed in a liquid or a gas. The first explanation
    of this phenomenon was given by Albert Einstein in 1905. He showed
    that Brownian motion could be explained by assuming the immersed
    particle was constantly buffeted by the actions of the molecules of the
    surrounding medium. Since then the abstracted process has been used
    beneficially in such areas as analyzing price levels in the stock market
    and in quantum mechanics.

  2. TheWiener processis the mathematical definition and abstraction of
    the physical process as a stochastic process. The American mathemati-
    cian Norbert Wiener gave the definition and properties in a series of
    papers starting in 1918. Generally, the termsBrownian motionand
    Wiener processare the same, although Brownian motion emphasizes
    the physical aspects and Wiener process emphasizes the mathematical
    aspects.

  3. Bachelier processis an uncommonly applied term meaning the same
    thing as Brownian motion and Wiener process. In 1900, Louis Bachelier
    introduced the limit of random walk as a model for the prices on the

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